Commodities Economic Outlook December 2016

Commodities: Outlook: Prospects for commodities remain positive

December 7, 2016

Commodities prices are set to break the pattern seen in the last four years in the final quarter of 2016. Prices for raw materials will increase in Q4 from the same quarter last year as a steady rebalancing in most markets continues and global demand rises. Analysts expect that commodity prices—according to an index produced by FocusEconomics—will increase 10.4% year-on-year, which contrasts the 26.7% plunge registered in Q4 2015 and the 8.8% drop in Q4 2014.

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Back at the start of this year, most analysts had held tepid expectations for prices for most commodities in 2016, mainly due to continued signs that markets remained well supplied and gains in efficiency were being made in several industries, despite the challenging global environment. Heading into 2017, and having already taken these effects into account, analysts now maintain a solid outlook for prices, despite risks related to uncertainty from recent events. The Consensus view among experts is that the overall price for the commodities covered in this report will rise 3.8% in Q4 2017 from the same quarter this year. Analysts’ expectations are not only driven by the individual fundamentals of each raw material within the energy, base metals, precious metals and agricultural groups, but also by other accompanying factors that are likely to influence either multiple commodity markets directly, or other markets—such as foreign exchange or interest rate markets—that, in turn, influence prices for raw materials.

In the coming year, volatility is expected to persist on the back of events such as the meeting of OPEC ministers scheduled for 25 May 2017, several key European elections, headlines about U.S. President-elect Donald Trump’s policy priorities and cabinet choices, and wider macroeconomic developments in both emerging and developed economies.

Energy Commodities Price Outlook l OPEC’s call to action

The disappointing performance of energy prices in Q3 has rapidly dissipated in the final quarter of the year. Prices are expected to rise 22.8% year-on-year in Q4, mainly due to a jump in crude oil prices caused by euphoria over OPEC’s agreement to decrease production. On 30 November, crude oil prices quickly increased more than 10% to over USD 50 per barrel for the first time since October after OPEC sealed the deal to reduce production by 1.2 million barrels per day (mbpd) to about 32.5 mbpd for six months from the start of January. The markets reacted positively to the accord, which includes an option to extend the agreement until the end of 2017. The deal is contingent on the participation of key non-OPEC countries—namely Russia—and the lion’s share of the cut will be made by Saudi Arabia and its Gulf allies. Iraq, OPEC’s second-largest producer, which had previously resisted cuts, agreed to reduce output by 200,000 bpd to 4.35 mbpd. Meanwhile, Iran was allowed to boost output slightly from its October level, which meant a major victory for Tehran as Iran has long argued that it needs to regain the market share it lost under international sanctions. Moreover, non-OPEC member Russia, which has bumped up production to new record highs in recent months, agreed to cut output by 300,000 mbpd. OPEC will meet with non-OPEC producers on 9 December.

The crude oil market has endured more than two years of low prices following the price collapse that started in mid-2014, and the loss of OPEC as a stabilizing market force in late 2014 served to exacerbate the problem. Due to heightened financial stress throughout most of 2016, in combination with usually warm weather, most energy prices—led mainly by oil—collapsed. However, they struggled to stay at low levels, as oversupply pressures eased following unplanned outages. Throughout most of the year, OPEC remained absent and prospects for a fast price recovery—driven by tighter oil market balances—had receded and the need became more pressing for OPEC to re-establish some price leadership. The downturn in the oil market lasted for longer than expected and this, compounded by a more resilient supply from non-OPEC countries in combination with record OPEC output, effectively forced the oil cartel’s hand to act.

In the final quarter of 2016, Brent Crude Oil prices are expected to average USD 50.3 per barrel and are seen strengthening further in the second quarter of 2017 due to the deal, reaching an average price of USD 54.9 per barrel. However, sharp gains will be limited as market skepticism lingers regarding how effective the cuts will be. Not all producers had complied with agreements on supply cuts in the past. Additionally, some downward pressure on prices is likely to come from the U.S. and other high-cost producers’ reactions to higher prices, with their production likely to ramp up. There are legitimate reasons to remain skeptical about the agreement, but analysts believe that OPEC’s action could accelerate the ongoing market rebalancing process. Analysts surveyed by FocusEconomics expect the price of Brent Crude Oil to average USD 58.5 per barrel in Q4 2017, which will push energy commodities prices to a 12.5% year-on-year increase.

Base metals prices rose in November and continued to rally at the beginning of December on the back of more bullish sentiment at this year’s LME Week—the annual meeting of the base metals markets—, a marked boost in trading volumes resulting from Trump’s promises of infrastructure spend and better results in manufacturing PMI data across the globe. Aluminium, copper, lead and zinc have gained the most by far and are expected to push base metals prices to an 8.7% year-on-year increase in Q4 2016 (last month’s forecast: +6.6% year-on-year).

The rally in most base metals prices was underway before the U.S. election results due to positive prospects for global economic growth next year, but the Trump victory has turbocharged price actions as analysts and market participants assume that U.S. growth will be boosted in the near term by his policies. They expect this despite the current strengthening of the U.S. dollar, higher interest rates and potential trade protectionist policies.

Economists forecast the boost to U.S. growth from fiscal changes to occur in the second half of 2017 and carry through 2018, although any drag on growth from potential protectionist trade policies remains a severe downside risk. Moreover, China demonstrated its efforts to support its domestic market again this year and, overall, growth in the country remained stable, driven by the commodity-intensive infrastructure, housing and automobile sectors, which have been the main drivers of demand for base metals this year. However, China’s transition to a consumption-led economy, together with industrial reform and environmental concerns, is likely to slow demand for raw materials and keep prices sluggish in the coming years. Following a rebound in the final quarter of this year, base metals prices are expected to continue rising strongly during the first half of 2017 and to moderate toward the end of the year. Analysts expect prices to increase 3.0% annually in Q4 2017.

2016 has been a rollercoaster ride for investor sentiment toward precious metals in general and gold in particular. Gold bottomed out at a record low on 17 December 2015 at USD 1,150 per pound a day after the U.S. Federal Reserve raised interest rates for the first time in nine years. Gold rallied in the following quarter, having risen around 20% as weak U.S. data and another yuan devaluation sparked fears. It then reached the highest level this year in early July at USD 1,370 per pound due to concerns about the consequences of the Brexit vote and continued trading in a narrow range around that level through the end of September.

In terms of monetary policy, the market’s main concern came in the second half this year, with another “taper tantrum” episode in sovereign bonds since monetary policy in the Eurozone, Japan and the U.S. (G3) was turning more neutral and less accommodative. Indicative of that sentiment was that global sovereign bond yields bottomed out in July and have been on a steadily upward trend since. The boiling point came in September when both the Bank of Japan (BoJ) and the European Central Bank (ECB) refrained from easing their policies further, while the U.S. Fed delivered a clear message for a potential December interest rate hike. With G3 monetary policy under review, precious metals prices experienced a major pullback in October to levels last seen pre-Brexit. Precious metals, gold in particular, had a moment of glory during the night of the U.S. presidential election as yields of U.S. Treasuries dropped precipitously and gold prices rallied, breaking USD 1,355 per pound. But as the initial shock wore off, the gains in prices were nearly retracted as investors’ chose to center on more positive global growth prospects as they had before the elections and largely ignored the many uncertainties the incoming Trump administration brings to both U.S. fiscal and trade policies. Palladium has been the exception among the precious metals. It is trading more like industrial metals as it remains well supported by trade and speculative buying. Prices have extended their upside momentum to reach fresh 17-month highs in the past days.

The precious-metals complex is not expected to receive any significant upside support in the final quarter of the year, following the strong rally in Q3. Prices are expected to increase 17.5% in Q4 2016 (last month’s forecast: +18.6% yoy) and, looking forward, the outlook for these metals remains grim as prices are seen dropping timidly. Analysts project that prices will decrease just 0.1% annually in Q4 2017 on anticipation that Trump’s fiscal and regulatory actions next year will drive U.S. yields, dollar and equity markets higher. Also, the risks around G3 central banks’ decisions could become more pronounced by mid-2017 as both the BoJ and the ECB could taper despite both having undershot the inflation targets.

Prices for the agricultural commodities covered in this report are expected to rebound in the final quarter of the year, following a bumpy road throughout most of 2016. Yields in most crops hit record highs through 2015 and 2016 and this trend may continue through 2017. Commodities experts project that prices for agricultural raw materials will increase 5.5% year-on-year in Q4 2016 (last month’s forecast: +5.0% yoy), which contrasts the 3.0% drop in prices observed in Q3. Stocks of most agricultural raw materials will draw down next year after having accumulated inventory during a number of seasons this year.

Due to a low price environment for most agricultural commodities, farm balance sheets and a preference to reduce the cost of inputs—including seed technology—combined with an uncertain weather outlook, are driving analysts’ more conservative estimates at this stage. Analysts expect that agricultural commodities will increase just 1.0% annually in Q4 2017 (last month’s forecast: +2.8% yoy). Due to a rebalancing of U.S. acreage and a more positive consumption outlook in 2017, inventories are expected to decline further next year. However, risks to the 2017 outlook are tilted to the downside. Prospects of a persistently strong U.S. dollar in 2017 and some ongoing volatility in exchange rates—particularly in emerging economies—should also continue to drive shifts in the competitiveness of leading agricultural commodities. In addition, the weather forecast for 2017 could prompt more price volatility across agricultural markets than was observed this year. The presence of a weak La Niña in Q1 2017 will continue to influence regional weather anomalies and output. However, the weakness in the intensity of the weather phenomenon makes forecasting the impact more difficult.

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